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The Use of Changes in Estimates to Meet or Beat Analyst Forecasts
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Managers exercise judgment in valuing a large portion of their balance sheets. As a mandatory requirement of maintaining faithfully presented financial statements, they are required to occasionally record a change in estimate and disclose the current period income effect of revision of the valuation assumptions for these assets and liabilities. Guidance requires managers to recognize these changes when new information is obtained regarding existing valuation assumptions. Given the unobservable and unverifiable nature of many of these assumptions, managers have significant latitude in the timing of such changes. Discretionary use of accrual accounts to manage earnings is well documented in accounting literature; however, the majority of these studies approximate discretion in accruals using models of expected accrual balances. Changes in estimates, however, provide the opportunity to observe the influence of manager valuation judgments without having to model expected balances. I find that firms tend to recognize income increasing changes in estimates advantageously to meet or beat analyst expectations. Additionally, recognition of income decreasing changes in estimates negatively impacts the likelihood to meet or beat. These results are consistent with extant earnings management literature and suggest managers time valuation modifications to beat expectations. I find that this result is robust to the use of a propensity score matched control sample or use of a fixed effect regression comparing a firm quarter to other quarters for the same firm. My results are robust to several changes in proxies, settings, and design choices. This paper contributes to the literature by showing a potential mechanism of earnings management. More important, this mechanism—changes in estimates—has mandatory footnote disclosure, which permits for analysis of discretionary use of accruals without the limitation of potential measurement error for discretionary accruals.
McCarthy, Sean (2017). The Use of Changes in Estimates to Meet or Beat Analyst Forecasts. Doctoral dissertation, Texas A & M University. Available electronically from